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Daily Newsletter, Wednesday, 04/03/2002

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The Option Investor Newsletter                Wednesday 04-03-2002
Copyright 2001, All rights reserved.                        1 of 2
Redistribution in any form strictly prohibited.


Posted online for subscribers at http://www.OptionInvestor.com
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MARKET WRAP  (view in courier font for table alignment)
*******************************************************************
      04-03-2002          High     Low     Volume Advance/Decline
DJIA    10198.29 -115.42 10339.86 10139.48 1.21 bln   1161/1984
NASDAQ   1784.35 - 20.05  1813.36  1770.61 1.55 bln   1361/2117
S&P 100   566.03 -  5.45   573.00   562.67   Totals   2522/4101
S&P 500  1125.40 - 11.36  1138.85  1119.68             
RUS 2000  496.60 -  3.89   501.53   495.87
DJ TRANS 2747.31 - 42.88  2795.30  2736.02
VIX        21.59 +  0.91    22.13    21.01 
VXN        41.10 +  1.78    41.39    39.86
TRIN        2.07 
Put/Call    0.64
*******************************************************************

Out Of Hibernation

The major market averages finished lower across the board
Wednesday.  Profit warnings and escalated tensions in the
Middle East pressured shares throughout the day.  But a late
announcement from Dell Computer (NASDAQ:DELL) could change the
tone Thursday, at least in the technology space. 

Bad Kitty

The Dow Jones Industrial Average ($INDU) fell to 10,198, lower
by 115 points, or a little more than 1 percent.  J.P. Morgan
Securities downgraded INDU component Caterpillar (NYSE:CAT)
Wednesday morning.  The stock was the worst performing
component with its 2.62 percent drop.  Other notable movers to
the downside included United Technologies (NYSE:UTX), 3M
(NYSE:MMM), Alcoa (NYSE:AA), and Microsoft (NASDAQ:MSFT).
Even DuPont (NYSE:DD), who raised the bar Wednesday morning,
finished 1.43 percent lower.  

The weakness in the cyclical-laden INDU came on the heels of
the Institute for Supply Management's (ISM) non-manufacturing
(services) index for March.  The reading fell to 57.3 percent,
below February's 58.7 percent, but still above the expansion-
revealing level of 50.  Nevertheless, the rate of expansion
slowed during March.

Poorer Poor's

The economic data, along with geopolitical fears, spread into
the broader market, pressuring the S&P 500 (SPX.X) 1 percent
lower.  The SPX.X finished at 1125, lower by 11 points.  On a
technical note, the SPX.X closed below its simple 50-dma for
the first time since late February.

The weakness in the financial and information technology
complexes pressured the SPX.X.  The broader financial group,
which includes banks, brokers, and insurers, is the largest
industry component of the SPX.X, accounting for about 19
percent of that index.  Information technology is second,
accounting for about 16 percent of the SPX.X as measured by
market cap.

Soft Speak

The Nasdaq-100 (NDX.X) was hammered for the second consecutive
session on growing earnings fears.  The NDX.X finished below
the 1400 level for the first time since late February at the
1394 mark, off by a little more than 1 percent.  Concentrated
weakness in software and semiconductor shares pressured the
tech-heavy NDX.X.  

The single biggest contributor to the NDX.X's weakness was
Microsoft (NASDAQ:MSFT).  The stock was hit again following
the Axe's bearish waxing Tuesday.  Softee accounts for about
10.50 of the NDX.X and an even bigger portion of the Software
Sector Index (GSO.X), which finished 2.26 percent lower.

"Truckin', Got My Chips Cashed In..."

The Dow Jones Transportation Average ($TRAN) was the worst
performing broad market measure in Wednesday's session.  The
index finished 1.53 percent lower to the 2747 level.  Counter
to the recent trend, the worst performing components of the
TRAN Wednesday were away from airline shares.  Granted, Delta
(NYSE:DAL) was grounded again Wednesday, but most airlines
traded well.  Instead, names like Norfolk Southern (NYSE:NSC),
Roadway (NASDAQ:ROAD), Alexander & Baldwin (NASDAQ:ALEX), and
Union Pacific (NYSE:UNP) were hit hardest.

I find the move in the TRAN over the last three trading days
the most disconcerting as it relates to the economy and
ultimately the market.  I consider the TRAN a key indicator
for the health of the economy.  It's this simple: increased
economic activity requires increased transportation services.
If you're a believer in the economic rebound thesis, you have
to be bullish on the TRAN.  Along that line of thinking, you
would view the recent weakness in the TRAN as routine backing
and filling.  Conversely, further deterioration in the TRAN,
perhaps a breakdown below 2650, would challenge any bullish
thesis on the economy.

Technically, the TRAN closed at a significant level Wednesday.
The long-term descending trend line that Jeff Bailey and I were
trading off of earlier this year could now serve as support if,
indeed, the economy is on the rebound and activity will continue
to grow.  That trend line currently sits right around the
2750 mark.  From there, I think you've got downside risk to
about 2650 -- the 38.2 percent retracement level of the bracket
below.

TRAN - Weekly Interval


 

Again, if you're bullish on the economy, you have to then be
bullish on the transportation companies -- the ones who will
benefit first from an increase in economic activity.  If you
have a bullish view on the economy, then a way to implement
that bias is through looking for TRAN stocks near meaningful
support levels, where risk is easy to manage and the potential
reward out weighs that risk.

Scanning the components of the TRAN, I found that CSX Corp.
(NYSE:CSX) finished at a significant support level after
Wednesday's slide.  The company is the simplest of transports,
operating a rail network in the eastern U.S, which spans from
Mexico to Canada.  The company is scheduled to report
earnings on April 22, with consensus estimates calling for a
profit of 33 cents per share.  What struck me about the stock
is that it stopped at its bullish support line, as well as
a double bottom at $36.  Coincidentally enough, the $36 level
also happens to be the current site of the stock's 200-dma.

CSX - Point and Figure 


 

It's pretty easy to manage risk right here with a stop at
$35, $34, or $33, depending on risk tolerance, with an upside
target in the low $40s.  If the economy is on track for
growth, then CSX should not breakdown below its very
meaningful support levels below.  If the stock does go on to
breakdown below its support, such a move would say a lot about
the state of the U.S. economy.  As it relates to other sectors
of the market such as tech and finance, a breakdown in the
transports would bode poorly for stocks in general.

Growling Gorilla

The heavyweight in the PC business, Dell Computer (NASDAQ:DELL),
reiterated its earnings guidance after the bell Wednesday.  The
company said that it was on track to earn 16 cents per share
for its first-quarter on slightly better-than-expected sales.
The news sparked a rally of about 30 cents in the after
hours session.  Other PC-related stocks ticked higher.

At its current rate, DELL is slated to earn 74 cents for its
current fiscal year.  That gives the stock a forward multiple
of about 36.  Going out to '04, Dell is expected to earn about
88 cents for the year.  Assuming Dell hits its numbers in '04,
that would mark an increase of about 19 percent over this
fiscal year's numbers.  That's not necessarily gangbuster earnings
growth, perhaps not enough to justify the current multiple; let
alone that 19 percent growth is two years away.  So therein lies
the problem with technology.  So what that Dell reaffirmed guidance.
The company needs to raise the bar, revealing that it's growing
more than expected, in order to justify the multiple and warrant
a higher stock price.  If anything, Dell's reiteration could
cause a short covering rally in tech tomorrow, but not a rally
with legs.

Just Say No

Bristol-Myers' (NYSE:BMY) shocker after the bell further
tarnished the once thought of defensive nature of the drug
makers.  The company announced a management shake-up while at
the same time issuing a warning for this quarter and the
full year.  The stock, which was whacked for its ties to
ImClone (NASDAQ:IMCL), was rocked in the after hours for more
than $5.  The Drug Sector Index (DRG.X) is threatening to take
out its February lows.  So much for defensive.

Know Your Risk

The bear that went into hibernation last fall is awake again.
By most measures, the market looks suspect to further downside.
The reasons for the renewed weakness are varied.  Accounting
fears are resurfacing, epitomized by the recent revelations at
Adelphia (NASDAQ:ADLAC), which Jeff Bailey nailed more than
20 points ago!  I'm sure there's more cockroaches where that
one came from.  The rising violence in the Middle East is a
risk that is un-quantifiable, but one that has to be heeded.
And then there's earnings season, or maybe the lack thereof.

The way that I'm personally trading is picking strong stocks,
based on niche theses, such as the recent trade that Jeff
Bailey profiled in the Market Monitor in Hanover Compressor
(NYSE:HC).  Aside from the small bullish operations, I'm
looking for relatively weak stocks near actionable points,
either near resistance or breakdowns.  Given the two big
back-to-back down days and the short-term pop in the VIX,
I'm expecting a relief rally in the next day or two, which is
why I've begun to lower stops on bearish positions, or lock
in gains.  There's plenty of profits to be made from the
bearish side in this market, especially using puts with as
low as the VIX still is.  To dismiss the bearish side is a
risk.

Eric Utley
Option Investor


********************
INDEX TRADER SUMMARY
********************

Buyers Strike
Leigh Stevens

The story of the market today was a continuation of moderate to 
light selling, coupled with very little buying interest.  
Selling hit the NYSE today as the Advance/Decline figures tipped 
more bearish at -816, versus only -140 yesterday.  The A/D for 
the Nasdaq Composite was about the same negative with the net 
advancing minus declining figures at -744, versus -782 yesterday.  

Downside momentum accelerated and I have no taste for trying to 
pick a bottom while prices continue down toward the lower 
envelope line that contains the typical up and down fluctuations 
of the Indexes. It has been uncanny how often a decisive upside 
or downside penetration of the 21-day moving average has led to a 
further move in this direction.  Until, that is, the Index 
reaches the outer band, as can be seen in the examples that have 
the circles and highlights below on the S&P 500 (SPX) below.   


MAJOR INDEXES: VIEWPOINT and TRADING STRATEGY:

In a word, we will attempt to buy at the lower end of the band, 
especially if there is a corresponding reversal from the area of 
the prior lows or around the 1100-1105 area.  The area for the 
OEX is in the 560 area, down to around 555 as a place where I will 
be looking for overall signs of a bottom.  

S&P 500 (SPX) and S&P 100 charts: 


  

Nasdaq Composite (COMP) and the Nasdaq 100 (NDX) Indexes:
The 1745-1747 area looks like our downside objective in the 
Composite (COMP) and the 1345 area in the Nasdaq 100 (NDX), at a 
minimum -- the Index can also follow the lower band lower.  



 


The Nasdaq 100 tracking stock, QQQ:


 
 

QQQ TRADE:
Bought the QQQ's at 36.00 on a 36.50 order, 4/2. Since my 
suggested stop was 1.5 under purchase, a stop at 34.50 was 
suggested. Our stop was elected today, 4/3 at 34.50

It appears from the above QQQ chart analysis that there may be a 
rebound to the high end of the hourly downtrend channel, but 
resistance at 35.50-35.75 needs to be overcome to suggest that 
this was more than a short-lived rebound.  A rally to above 36, 
with subsequent support developing in this area, would kick in 
the bullish Wedge scenario on the QQQ daily chart, also above. 


NEW LONG TRADE SUGGESTIONS: NONE 

NEW SHORT TRADE SUGGESTIONS: NONE

NOTE: Risk to Reward guidelines:  Determining an objective is 
important, even if it is a moving target, as this is the reward 
potential.   Determining reward potential is critical to 
establishing whether a stop that makes “sense” (e.g., a sell stop 
that was placed under a key support level) would, if triggered, 
result in a dollar loss that is in proportion to profit 
potential; e.g., 1/3 of it.  (On occasion, when the purchase 
price of call or put is equal to 1/3 or less of the estimated 
reward potential, there may not be a specific exit suggestion, as 
the cost of the option is equal to the amount that is being 
risked.)   


KEY LONG-TERM MARKET INDICATORS: 

Relevance and use of these longer-term Indicators:  
The indicators here could be defined as primary ones and used to 
“time” entry into or out of the market on an intermediate-term 
basis; e.g., the 3 to 6-week or longer time-frame.  While many 
index trading suggestions may be short-term in duration (e.g., 2-
3 days up to 2-3 weeks) the picture present of the market on a 
more medium-term basis will form the foundation of trading 
strategy.  For example, a short-term put position taken when the 
market is in process of coming down to an intermediate low and an 
oversold condition, will not warrant a “full” position or 
warrant the same trading capital that could be committed on a 
high-potential trade, such as where a significant bottom is 
indicated, or, conversely, when a major top is suggested. The 4 
major indicators, plus moving averages and their variations 
(envelopes), will help keep market perspective and manage risk.


ADVANCE/DECLINE INDICATOR: 
The 10-day figures on the Net Advance-Decline figures for both 
the S&P and the Nasdaq, are approaching oversold bullish readings 
for the NYSE Exchange and is near to a similar bullish oversold 
reading for the Nasdaq.



 


ADVANCING VOLUME FIGURES: 
Advancing volume figures, on a 10-day basis are also in the area 
where expansion begins again.  The upside volume indicator is a 
leading one as it tends to "lead" upside reversals.  



 


ADVANCE/DECLINE "OSCILLATOR":
A 10-day moving average (blue) of the daily total of advancing 
stocks minus the number of stocks declining that day (i.e., the 
net A/D figure) can be used like an overbought oversold 
oscillator.  When this figure rises or falls to certain areas, 
the market is considered to be overbought or oversold. (The Q-
charts figure plotted above, is a fair approximation of the daily 
figure, but a more precise source for this information is being 
compiled.)       

UPSIDE VOLUME INDICATOR: 
Upside volume is the most important volume figure, as it measures 
the amount of stock bought on up ticks and the general 
willingness of traders and investors to pay up for stock.  When 
the 10-day moving average (blue) of volume contracts to certain 
reoccurring areas, in terms of a 10-day moving average of the 
number, it tends to reflect the potential for a substantial rally 
ahead -- "volume precedes price".  

SENTIMENT INDICATORS: 
All the Sentiment Indicator having to do with bullish or bearish 
excess, remain in NEUTRAL territory, as far as the put versus 
call daily volume figures (or the reverse, calls to puts in the 
case of the CBOE Stevens Equities-only figures).  

However, these are edging toward a more bullish reading as put 
buying is on the upswing.  



 



 

Leigh Stevens
Chief Market Strategist 
lstevens@OptionInvestor.com 


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***********
OPTIONS 101
***********

A Primer on Online Volatility Tools - Part I
By Mark Phillips
mphillips@OptionInvestor.com

Two weeks ago when we parted company, I promised to delve into
the topic of some of the tools that are available online for
assessing volatility.  We've already spent a fair amount of time
looking at the volatility charts on www.iVolatility.com, but
there is plenty more information available on that site.  In
fact, I dare say that site has a greater wealth of information
available on the topic of volatility than any of us truly need.
But it is a powerful resource for the nuggets of information
that we find useful.

There is a neat little option calculator available on the site,
which provides a nice complement to the historical and implied
volatility charts.  Recall that the historical volatility (HV)
is a volatility measure on the stock, and the implied volatility
(IV) is a measure of the aggregate or average implied volatility
of all the options on that particular security, both puts and
calls.  While that's fine for determining whether it is a
favorable climate for buying or selling options, when we get
ready to actually implement a trade, we'd like to have more
precise data on the specific option(s) that we are considering
buying or selling.  That's where the option calculator comes in.

Let's get everyone on the same page here, so that you can follow
along on the site while we go through the example.  Bring up the
main page by typing in http://www.ivolatility.com.  There is a
line of links across the top of the page, beginning with Home
and ending with Data Sales.  The link we are interested is the
one labeled Calculator.  Click on that link and then after
agreeing to the disclaimer page, you will be taken to a page
with an option calculator.  Here's what it looks like.



 

We're going to go through this exercise on the IBM example that
we've been talking about since we began our journey into the
subject of the Greeks over two months ago.  Please make a note of
the fact that I am writing this article on Thursday, March 28th,
ahead of the holiday weekend for publication on April 3rd.  So the
actual numbers used in the examples here will be a bit stale.
Hopefully that doesn't cause too much confusion, as it will make
it far easier for me to enjoy my traveling this week.

We know from our recent work with the volatility charts that the
volatility on IBM is currently near the lower end of its
historical range.  That means that the current climate in IBM
favors option buyers, rather than option sellers.  With IBM
currently trading near $105, let's see what the calculator tells
us about the Greeks on the May ATM put and call.

Enter IBM in the Symbol field at the top of the Calculator
function, select the upper right Stock Symbol radio button and
click on the check mark to fill in the fields in the calculator.
Voila!  The calculator fills in all the fields, telling us what
the current price is, entering in the strike price that is
closest to the money (in this case 105), front month (in this
case April) expiration cycle is selected and then the application
goes ahead and fills in the rest of the pertinent details.  Days
to expiration (DTE), Volatility % (this is the HV of the stock),
Risk-free interest rate, and dividend data.  That alone is some
good information, but what we are really interested in is the
data provided in the Put and Call columns.



 

In addition to providing us with the appropriate option symbols
and their theoretical values, the calculator gives us values for
Delta, Gamma, Theta, Vega and Rho.  We haven't talked about Rho,
which is related to interest rates, and is the one Greek that I
tend to ignore.  I don't consider it to be an important factor in
the analysis of option pricing and I don't want to confuse the
issue by trying to add it to the mix.  But look at all that other
good data we have to digest!  This is a gold mine of information
for those that know how to interpret the data, and that has been
the focus of our attention here in this column for these past
many weeks.

On the far left of the calculator page, there is an orange link,
Calculators Help, which provides excellent step-by-step
instructions on how to use and interpret each of the fields in
the calculator.  As you can see from the information provided in
the online help, most fields in the calculator are filled in
automatically, leaving us to focus on those that we are
interested in.  The inputs that we want to change of course are
the Expiration Month and the Strike Price.  So feel free to
experiment, putting in different values for these fields.

Isn't it interesting to note that for the same strike price,
Delta will change for different expiration months?  That's
right, Delta increases as the amount of time to expiration
increases.  That is one reason why a LEAP will move slightly
faster with changing price in the underlying equity than will
a front-month option.  Do you notice any sort of a pattern in
volatility as you change the expiration month in the calculator?
Righto again!  This is a very powerful piece of data, and it is
our first glimpse at the concept of Volatility Skew.  While
we'll likely spend a couple of future articles talking about
the intricacies of this concept, the basic idea is that different
strike prices and expiration cycles of options on a given
security will be priced differently due to differences in
option-specific volatility.  If we know what to look for, we can
craft combination trades to take advantage of this inefficiency.

Coming back to the calculator, there is another interesting piece
of information that you might not have noticed yet.  As you go
out further in time (say from April to September expiration),
note that the values for Theta continue to decrease.  This is a
manifestation of the fact that time decay is slower in
distant-month options and moves much more rapidly in front-month
options.  Look how much lower Theta is for both the Puts and the
Calls in the graphic below (vs. the example above using
front-month options), where we have selected JAN-03 as the
expiration month.



 

If information is power, than I dare say many of you are feeling
like you are ready to take on Tim, "The Tool Man" Taylor, of Home
Improvement fame.  But hold onto your horses, because next week
we're going to cover another powerful online tool that can
quantify our odds of success in any given option trade, based
solely on current and expected prices and the present value of
volatility.  Doesn't that sound like a tool worth adding to your
tool bag?

Oh, one last thing before I wrap this up.  See that little
Implied Volatility window lurking at the bottom of the Put/Call
section of the Calculator?



 

Now that's really a handy little tool.  We can enter in the price
of an option, specify whether it is a put or a call, and the
application will tell us what the implied volatility of that
option is.  That can give us an indication if the option we are
considering is expensive or cheap in terms of volatility.

Until next week, happy exploring!

Mark


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***********************
INDEX TRADER GAME PLANS
***********************

Sector News and Views 
Leigh Stevens 

To get a fuller picture of the market use this section in 
conjunction with the Index Trader Wrap up. 

The big talk as far as sectors is concerned is more about 
capitalization SIZE factors, the talking heads today found plenty 
of reason to like the small to medium capitalization issues, as 
can be purchased through such instruments as AMEX iShares of the 
SmallCap Index fund (Q-Charts symbol: IJR or variations of this 
Index: one is a "value" fund that my old colleague John Bollinger 
favors. IJS is value fund symbol -- for more info go to 
www.amex.com

What was first recently became last today as profit-taking 
selling hit the stocks in the natural resource type sectors -- 
Gold & Silver Sector Index (XAU -2.9%), the Oil Service Sector 
Index (OSX -2.9%)the Natural Gas Sector (XNG.X -2.3%), the GSTI 
Software Index (GSO -2.3%) and the Semiconductors (SOX -2.2%).

I still like playing the short side of precious metals and have a 
suggestions with XAU Puts below.  Basically this move in the 
precious metals is overdone according to my technical indicators, 
and prices will come back down from the level of risk premium 
that they command now. I think oil is near a top as well but 
don't have a suggestion on this.  

 
TRADE PLAYS AND GUIDELINES: 

Sector: XAU (PHLX Gold & Silver Index)


 

TRADE SUGGESTIONS:  

BUY May 65 and May 60 puts on a scale up basis with XAU above 73, 
extending up to the 80 area.  

These puts are currently cheap but did rebound a bit today, as 
the XAU faltered on probable profit-taking.  

Objective: XAU to 61
Stop: XAU close above 80
Time frame: 4-6 weeks.

Sector: RTH: AMEX Retail Holding Stock


 

OPEN TRADE SUGGESTION:

Sector: RTH (AMEX: Retail sector trust stock)
Trade Entry: SHORT at 99.00 or better  
Objective: 90
Stop: 102 
Time frame: 3-6 weeks.

Will leave this as a short recommendation even though stock 
continued still lower today (close: 96.05) and our chance of a 
fill lessens. I re-visit this updated chart today as it well 
illustrates the rising bearish WEDGE pattern.  You see the 
reverse of this pattern, that of a possible bullish falling 
wedge, in the current QQQ Daily chart as seen in the Index Trader 
Wrap of today (4/3).


OPEN LONG TRADES: NONE


OPEN SHORT TRADES:

Sector: XLB at 23.75
Stop: 24.50

Sector: XLP at 26.00
Stop: LOWER to 26.25, from 26.75

Sector: IYD at 45.25
Stop: LOWER to 46.60, from 47.00


Sector: IYR at 84.75
Stop: 86.00 (4/3 HIGH @ 85.54)

Sector: IYE at 49.70
Stop: 52.00 

RISK to REWARD guidelines:  
Determining an objective is important, even if it is a moving 
target, as this is the reward potential.   Determining reward 
potential is critical to establishing whether a stop that makes 
“sense” (e.g., a sell stop that was placed under a key support 
level) would, if triggered, result in a dollar loss that is in 
proportion to profit potential; e.g., 1/3 of it.  (On occasion, 
when the purchase price of call or put is equal to 1/3 or less of 
the estimated reward potential, there may not be a specific exit 
suggestion, as the cost of the option is equal to the amount that 
is being risked.)   


Leigh Stevens
Chief Market Strategist
lstevens@OptionInvestor.com


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The Option Investor Newsletter                Wednesday 04-03-2002
Copyright 2001, All rights reserved.                        2 of 2
Redistribution in any form strictly prohibited.


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*****************
STOP-LOSS UPDATES
*****************

VARI - call
Adjust from $36 up to $36.50

UNH  - call
Adjust from $74 up to $75

IBM  - put
Adjust from $106 down to $103.50

CVG  - put
Adjust from $31.50 down to $29.75

CTX  - put
Adjust from $53 down to $52.50

TMPW - put
Adjust from $37 down to $35

GNSS - put
Adjust from $27.50 down to $26.50

VRSN - put
Adjust from $29.25 down to $28.25


*************
DROPPED CALLS
*************

KLAC $64.60 -1.06 (-1.90) KLAC pulled back again in today's
session along with the weakness in the Semiconductor Sector
Index (SOX.X).  The SOX.X finished 2.22% lower, while KLAC
finished 1.61% lower.  The stock once again out performed its
broader sector, but its relative strength wasn't enough to
keep it above short term support.  With downside likely in
the coming sessions and our stop violated, we're dropping
coverage tonight.  Look to cut losses early tomorrow on any
strength from the late Dell news.

LH $93.20 -2.30 (-2.66) LH continued lower in today's
session after its recent run-up.  Hopefully traders booked
gains ahead of today's weakness, as we experienced a solid
rally in this play.  We were playing it tight with a stop
near the 10-dma, and unfortunately LH closed below that
level today.  We're dropping coverage based on that stop
violation, but will look to revisit this play once it forms
a short term base.


************
DROPPED PUTS
************

None


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*********************
PLAY OF THE DAY - PUT
*********************

HLIT - Harmonic $11.45 +0.83 (-0.15 this week)

Harmonic, Inc. designs, manufactures and markets digital and fiber
optic systems for delivering video, voice and data services over
cable, satellite, telco and wireless networks. Harmonic's products
fall into two principal groups, Broadband Access Networks Products
and Convergent Systems Products. In addition, the Company provides
Professional Services and Systems Support to its customers
worldwide.

Most Recent Update

HLIT pulled back in today's session, but rebounded back above the
$10.50 level near the close of trading despite the ugly finish in
the broader technology sector.  The stock continues to display
signs of relative strength and should be the first out of the
gates when the tech sector rebounds.  Traders looking for entries
on weakness can start looking to take positions from current levels
or slightly lower in tomorrow morning's trading.  If the $10.50
support level continues holding, traders can look for signs
of stabilization in the broader tech measures and consider
entries off of $10.50.  Our coverage stop is still in place
at the $10 level, which can be used by those who take entries
from current levels or slightly lower.  Those looking for
confirmation can wait for strength in the Networking Index
(NWX.X) to carry HLIT back above the $11 level.

Comments

SoundView Tech upgraded HLIT to a strong buy Wednesday
morning.  The stock responded with a 7.81% gain on the day.
Obviously the shorts are nervous with this stock.  A breakout
above $12 tomorrow could induce the next leg of short covering.
Play it with a tight stop and look for a quick exit up around
the $13 level.  Use in the money contracts.

BUY CALL APR-10*LOQ-DB OI= 615 at $1.75 SL=1.00 
BUY CALL APR-12 LOQ-DV OI=1401 at $0.40 SL=0.25 
BUY CALL MAY-10 LOQ-EB OI= 132 at $2.25 SL=1.25 
BUY CALL MAY-12 LOQ-EV OI= 423 at $1.10 SL=0.50 

Average Daily Volume = 1.33 mln



*****************************************
BIG CAP COVERED CALLS & NAKED PUT SECTION
*****************************************

BIG-CAP COVERED CALLS, NAKED PUTS & COMBINATIONS
***************
Trading Basics: Strategy Selection
By Ray Cummins

One of our readers asked about the use of "sell-strangles" on
indexes as a viable premium-selling strategy in a volatile
market.

***************

MAILBAG - Reader's Comments & Questions

***************

Attn: OIN Spreads/Combos Editor

I read with interest last week's question about the collateral
requirements in the "Condor" credit spread. While that technique
appears to offer a simple low-risk approach to spread trading,
I am hesitant to write options on individual equities with the
market in such a volatile condition. I have more interest in
selling options on the major indexes, where there is far less
chance for a drastic movement. What do you think about using
this strategy with out-of-the-money options (I think it is a
sell-strangle?) and do you have any suggestions for a fairly
new trader who might use it in the future.

HT


Regarding "Sell-Strangles" and Selling Options on Indexes:

The credit strangle or "combination" is a neutral-outlook options
strategy in which the trader sells a call and a put on the same
underlying instrument, with the same expiration date, but with
different (out-of-the-money) strike prices.  The major advantage
to this technique is that the trader has a wide margin for error
in predicting how the underlying will move in the future.  Some
people believe the position is called a "strangle" because it
suffers a higher rate of time (premium) decay than an individual
short option but in fact, the unique label emerged in 1978 after
a number of traders holding short positions in IBM options "lost
their shirts" as a result of unexpected price swings.  Indeed,
the strategy has unlimited risk and limited profit potential, and
is subject to large margin requirements, thus it is best suited
to traders with substantial portfolio capital.  The credit strangle
will profit from limited stock activity and will suffer losses if
the underlying stock moves significantly in either direction.  A
successful outcome occurs when the price of the underlying finishes
the expiration period between the sold strike prices, but profits
can also be achieved through the depreciation of option premiums
over time.

Unlike most option trading strategies, which depend on directional
forecasts and accurate market timing, the credit strangle is best
suited to range-bound issues where the trends have less bias and
extreme movements are rare.  The idea is to construct a position
that generates acceptable returns and yet, has a wide range for
success.  In choosing the underlying issue, the trader must balance
his desire for volatility, which produces excess premium in the
options, against the probability of unexpected activity, which may
result in position losses.  Since the primary risk to an option
writer (after the short position has been initiated) is unexpected
volatility, the easiest way to avoid this problem is to focus on
issues that are not subject to large, gapping moves.  One category
of financial instruments well suited to this strategy is the equity
index.

Professional money managers employ a number of different techniques
to profit from the broader market movements and one of the most
common hedging strategies is writing "out-of-the-money" options on
the major equity indexes.  Traders who use these techniques often
utilize S&P 100 Index (OEX) or S&P 500 Index (SPX) options because
they contain more premium than options on individual stocks and
also provide an instrument less prone to large, unexpected moves.
In the Spreads/Combos section of the OIN, we favor debit spreads on
the S&P 500 index for momentum and hedging, as well as "out-of-the-
money" credit spreads on the S&P 100 index when the premiums are
acceptable.


Here are some guidelines for selling index options:

1) Utilize broad-based indexes such as the S&P 100 index, or other
major market indexes, and focus primarily on options that are
"deep-out-of-the-money," preferably at well-defined support and
resistance areas.  Remember, the key to success in this strategy
is to initiate a position (or spread) where the sold options are
far from the index value, thus reducing the probability that the
underlying will ever trade near the break-even points.

2) Perform a volatility analysis of the underlying issue and the
target spreads.  Most professional traders construct their plays
based on statistical volatility and the value of this type of
assessment cannot be overstated.  A thorough study of historic
option pricing can also help determine which series offer viable
premiums when compared to relative fair values.
 
3) Establish a stop-loss (mental or mechanical) that is well inside
the break-even points of the position and never allow a short option
to become "in-the-money."  If the underlying moves sharply in one
direction early in the life of the position, consider closing the
spread that is in jeopardy, even if the stop-loss has not been hit.
With this type of conservative, sensible approach, you will rarely
incur the maximum loss.

4) Write index options that have no more than one or two months
remaining until expiration.  Maximum time value erosion occurs in
the last month of an option's life, and with less time for any
unexpected volatility, you have a higher probability of profit.

5) Consider the use of "net-debit" or "net-credit" orders to
initiate and close combination positions.  This is, by far, the
safest way to trade spreads.  Experienced traders also favor
contingency orders, where you place a limit price for one of your
transactions and either a market or a limit price for your other
transaction, to implement simultaneous trades.  The technique is
very useful with multiple positions because the second order will
be put into play only after the first transaction is completed.

Good Luck!

***************
Summary of Current Positions
***************
(As of 04-02-02)

Naked Puts

Stock  Strike Strike  Cost Current  Gain  Potential
Symbol  Month  Price Basis  Price  (Loss) Mo. Yield
COF      APR    50   48.60  63.99   1.40     5.6%
CEPH     APR    50   48.35  65.93   1.65     7.9%
KLAC     APR    55   53.30  65.66   1.70     6.9%
PHTN     APR    45   43.30  48.97   1.70     7.0%
GILD     APR    28   26.75  36.07   0.75     6.4%
ACS      APR    48   46.60  55.76   0.90     4.4%
COF      APR    50   49.10  63.99   0.90     4.9%
SYMC     APR    35   34.35  39.95   0.65     5.2%
CYMI     APR    40   39.50  49.96   0.50     4.7%
GILD     APR    30   29.55  36.07   0.45     5.7%
ROOM     APR    55   44.25  58.31   0.75     6.3%
GILD     APR    33   32.10  36.07   0.40     5.1%


Naked Calls

Stock  Strike Strike Break Current  Gain  Potential
Symbol  Month  Price  Even  Price  (Loss) Mo. Yield
NVDA     APR    70   71.00  42.49   1.00     5.6%
QLGC     APR    60   60.85  48.83   0.85     5.8%
PSFT     APR    43   43.30  25.16   0.80     7.2%
BRCM     APR    45   45.45  34.49   0.45     6.1%
SEBL     APR    38   38.05  31.82   0.55     7.7%


Put-Credit Spreads

Stock                                           Gain
Symbol  Pick  Last  Month L/P S/P Credit  C/B  (Loss)  Status

BBY    75.27  75.01  APR   60  65  0.55  64.45  0.55    Open
CI     96.38 104.54  APR   80  85  0.60  84.40  0.60    Open
FRX    83.65  83.14  APR   70  75  0.50  74.50  0.50    Open
TOL    26.50  24.80  APR   20  22  0.32  21.20  0.32    Open
VLO    47.85  48.76  APR   43  45  0.40  44.60  0.40    Open
CI     98.90 104.54  APR   85  90  0.50  89.50  0.50    Open
NKE    63.99  57.66  APR   55  60  0.50  59.50 (1.84)  Closed
WFMI   47.09  45.09  APR   40  45  0.60  44.40  0.60    Open
WSM    49.05  44.94  APR   40  45  0.55  44.45  0.49    Open
GD     95.24  94.90  APR   85  90  0.60  89.40  0.60    Open
SLM    98.01  97.25  APR   90  95  0.50  94.50  0.50    Open

The slump in Nike (NYSE:NKE) shares continued this week as the
the broader equity markets retreated.  Our bullish position was
in jeopardy after the company posted a dim near-term outlook for
revenue growth and as we noted last week, traders were watching
for a reaction as the issue reached a recent support level.  In
this case, the buying did not resume and we were forced to exit
the play for a small loss.  There are two other issues; WSM and
WFMI, in similar circumstances (at support/sold strike) and we
will monitor their technical patterns for indications of a new
bearish trend.


Call-Credit Spreads

Stock                                           Gain
Symbol  Pick  Last  Month L/C S/C Credit  C/B  (Loss) Status

LXK    50.48  54.90  APR   65  60  0.60  60.60  0.60   Open
BRCM   40.24  34.49  APR   55  50  0.55  50.55  0.55   Open
LEH    63.49  63.20  APR   75  70  0.60  70.60  0.60   Open
QLGC   48.96  48.83  APR   65  60  0.65  60.65  0.65   Open
CCMP   65.73  66.87  APR   80  75  0.60  75.60  0.60   Open
RE     66.00  68.09  APR   75  70  0.60  70.60  0.60   Open
BRKS   44.32  44.20  APR   55  50  0.50  50.50  0.50   Open

 
Debit Straddles/Strangles: 

Stock  Position    Debit  Target   M/V      G/L      Status

NTRS   APR60C/60P  4.00    5.00    3.50    (0.50)    Closed?
DST    MAY50C/50P  3.90    5.50    3.75    (0.15)     Open
EMLX   APR32C/30P  3.65    4.35    4.50     0.85     Closed?
VRTS   MAY45C/40P  2.75    3.30    3.70     0.95     Closed?

The recent volatility in technology issues was a bonus for our
new speculative debit-strangles as both Veritas (NASDAQ:VRTS)
and Emulex (NASDAQ:EMLX) achieved near-term profit targets.

 
Synthetic Positions:

Stock  Pick     Last    Position   Credit   C/B    G/L   Status

APOL   65.80   62.03   MAY65C/45P  (0.20)  44.80  (0.20)  Open
NUE    53.30   52.68   APR70C/60P   0.10   59.90   0.10   Open


***************

STRATEGY SELECTION - Spreads & Combinations

One of our readers asked if we would talk more about specific
combination strategies and since I am away from the market this
week (with a new baby girl!), we have an excellent opportunity
to discuss one of the easiest and most successful debit-spread
techniques for option traders.

***************
A Classic Combination: The Diagonal Spread

The options market offers a number of tools and techniques that
can help the astute trader construct a powerful portfolio; one
which possesses a high degree of safety with consistent returns.
Through the use of combinations, the trader has a vehicle to
pursue a wide variety of strategies.  The complete option player
can profit with bullish and bearish plays in situations that
dictate either aggressive or conservative positions.  With an
understanding of the risk-reward relationships between long and
short options at different prices in varying time periods, he can
benefit from the most advanced techniques available in the market.

The majority of traders utilize spreads to reduce the cost and the
risk of option ownership.  They construct combination plays with
partially offsetting option positions to reduce the potential for
capital loss.  Spreads can be designed to generate return diagrams
of almost any character but unfortunately, the fundamental benefit
of this type of trading is also its downfall; the potential gains
are limited.  The most popular types of combination positions are:

Price (vertical) spreads - the purchase of an option at one strike
price and the sale of another option with a different strike price.
The potential profit in this strategy is based solely on a correct
forecast of the direction of the market.

Time (horizontal) spreads - the purchase of an option with one
expiration month and the sale of another option with a different
expiration month.  This type of spread benefits from the faster
decay in the time value of the short-term.

The diagonal spread is a combination of price and time spreads.
The most common version of this strategy requires the purchase of
a long-term call and the sale of a short-term call at a higher
strike price.  In most cases, the initial debit of the position
should be less than the spread between the two options, removing
the possibility of loss in an upside break-out.  The advantage of
this strategy is the cost basis of the long position is reduced
by the sale of the short-term option.  The spread achieves maximum
profit (at expiration) if the stock price remains above the sold
option's strike price.  In addition, the spread can profit (before
expiration) if the underlying issue advances significantly in a
short period after the play is opened.

In many cases, a diagonal position offers a big improvement over
the standard price spread.  If the stock price remains relatively
unchanged or falls slightly, the long option will retain more value
because of its extended maturity.  If the near-term (sold) option
expires, the position can be reestablished with the sale of a new
option.  If the long option is current month, the position can be
converted to a normal price spread.  Once again, if the underlying
issue rises above the sold (short) strike price, the spread will be
profitable.  With longer-term options, the character of the spread
can be adjusted to match the outlook of the underlying issue.  A
neutral or bearish position can be established with the sale of an
ATM option or the original spread can be duplicated (at a lower
cost basis) with the sale of a new OTM option.  In either scenario,
the long-term diagonal spread benefits from the sale of additional
options throughout the life of the (long) position.

The majority of advantages in a diagonal spread are obvious but
there is one characteristic that most traders overlook.  In a debit
spread, if the stock advances substantially and the options trade
at parity, the maximum potential profit will be limited to the
difference between the strike prices.  With a diagonal spread, the
long option has more time premium.  Thus, when the underlying issue
trades near the strike price at expiration, the value of the spread
will grow beyond the theoretical profit range.  With that in mind,
it's easy to see why the maximum profit potential (at expiration)
occurs at the strike price of the sold option.

Another method that is commonly used to increase the probability
of profit in this strategy requires an understanding of relative
value and implied volatility in option pricing.  When opening or
adjusting any type of spread, it's important to take advantage of
the highest relative premium to create the best possible position.
The exploitation of option pricing disparities is also paramount.
In the majority of portfolio positions, we try to open new spreads
only when there is a disparity in pricing (most likely from excess
value in the sold option).  This technique allows us to enter plays
with a theoretical edge, at a discount.

For the investor who is not familiar with position trading, this
strategy offers an excellent opportunity to learn the basics in a
low risk environment.  The concept of the diagonal spread is easy
to understand and once established, the position can be managed
with little difficulty.  The occasional adjustments also provide
the necessary background for more advanced techniques.  Those who
enjoy aggressive directional trading can construct positions to
fit their style as well.  Although the potential for upside profit
is reduced, the limited downside exposure provides a favorable
risk-reward ratio for the majority of investors.

Until Next Week...

***************


SEE DISCLAIMER
*****************************


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